How Does the Sarbanes Oxley Act of 2002 Affect Small Business Owners?

by Lisa Magloff, Demand Media

The Sarbanes-Oxley Act places a greater accounting and reporting burden on small businesses.

Calculating payments image by Christopher Meder from Fotolia.com

The Sarbanes-Oxley Act was passed in 2002, after corporate scandals involving fraud and regulatory mismanagement in companies such as Enron and WorldCom. The Act dictates how all public companies are required to disclose financial information. The requirements of the Act can place a burden on small businesses, and penalties for noncompliance are very serious. It is vitally important that all businesses are familiar with what the act requires.

History

Congress passed the Sarbanes-Oxley Act following corporate scandals in which companies went bankrupt after giving false or misleading financial reporting that showed they were more financially sound than they actually were. Enron, for example, deliberately misrepresented large numbers of transactions to government auditors, in order to hide huge loses. Senator Paul Sarbanes and Representative Michael Oxley proposed the Act to strengthen corporate accountability and governance and prevent this type of fraud.

Significance

The Sarbanes-Oxley Act was intended to protect investors by requiring internal accounting checks and balances within a company and ensure accurate financial reporting and transparency. The act holds a company's executive officers and financial officers responsible for financial information, and requires companies to report a great deal of financial information and to have in place procedures to ensure their financial records are valid.

Features

The Act includes measures to grant outside auditors more access to data and protections for corporate whistle blowers. The Act makes it a crime for companies to publish financial statements containing false or misleading information, or that omit information important to the company's fiscal health. It also holds executives legally responsible for all financial statements and for all internal auditing controls. Company accountants must report changes to the company's finances when they occur, rather than wait until the next financial report.

Effect on Small Companies

The Sarbanes-Oxley Act applies to any public company, no matter the size. Because the Act requires a high level of financial reporting and internal auditing, it can place a burden on smaller companies to make sure they are in compliance. The management of all companies has a legal duty under the law to maintain a system of auditing controls to ensure financial statements are reliable. There are no rules about what system to use. While large companies design their own system, most small companies do not have teams of auditors and accountants to do this. Instead, small companies can use the free framework designed by the Committee of Sponsoring Organizations of the Treadway Commission (see the resource below).

Section 404 Audits

One of the most difficult elements of the Act for small companies is the requirement that all annual reports include the company's own assessment of its system of financial reporting. This assessment must show that there are enough controls in place to safeguard the accuracy of the company's financial data. This assessment is called a Section 404 audit, and is done along with a financial audit. This has proved the most onerous part of the Act for small companies, because it means spending more money on auditors' reports and collecting more types of financial information.

Penalties

For companies not in compliance with SOX, the penalties range from loss of insurance, and de-listing from the stock exchange to huge fines and imprisonment. Penalities vary depending on which part of the law is violated. For example, any employee who deliberately hides or alters information can get up to 20 years in jail, and a CEO or CFO who deliberately submits an incorrect Section 404 audit can be given a $1 million fine and up to 10 years in jail.

About the Author

Since graduating with a degree in biology, Lisa Magloff has worked in many countries. Accordingly, she specializes in writing about science and travel and has written for publications as diverse as the "Snowmass Sun" and "Caterer Middle East." With numerous published books and newspaper and magazine articles to her credit, Magloff has an eclectic knowledge of everything from cooking to nuclear reactor maintenance.

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